On the Proper Use of Family Limited Partnerships

An article in the Wall Street Journal, “Covering Your Assets” (WSJ, April 12, 2009), attempted to provide guidance on the proper use of Family Limited Partnerships. Unfortunately, this article has led to much confusion. Our comments below are intended to provide some clarity and guidance on the proper use of FLPs.

First, we address the general issue of whether FLPs may contain personal assets, in light of the Journal’s warning that FLPs should only be used for business purposes. From that broad issue, we then discuss the narrow question of whether a personal residence may be owned by an FLP. Finally, we analyze whether there is a certain percentage or amount of one’s assets that may be placed in a partnership.

The underlying premise of the article is that FLPs are strictly business entities. Based on this premise, the Journal approves the transfer of stock of a family owned business and commercial real estate to an FLP, but warns against the transfer of non-business assets such as homes or cars to an FLP. However, this premise is wrong. Nowhere in the Revised Uniform Limited Partnership Act, or in the limited partnership laws of any state which govern limited partnerships such as Family Limited Partnerships, is there a limitation that such partnerships operate solely for business purposes. In fact, FLPs do have important non-business purposes, including: estate planning benefits, tax planning advantages, consolidation of assets, centralization of family control over assets, better family succession, and, of course, asset protection benefits . Establishing an FLP plan for both tax planning and non-tax reasons strengthens the FLP plan in the eyes of the IRS, as the Journal advises. But, as the Journal also notes, if the sole purpose of an FLP is for tax avoidance, then the IRS might ignore that FLP for tax purposes only. However, both the Journal and the IRS recognize the valid purposes behind FLPs, besides tax avoidance. The discussion of underlying business or economic purpose for an FLP is relevant to the tax treatment of the FLP by the IRS, not to the validity of the FLP for asset protection or any other (non-tax) purpose.

Having established the non-business utility of an FLP, we may now address the Journal’s statement that one’s personal residence should not be placed in an FLP. With all due respect to the Wall Street Journal reporter, we disagree with this conclusion. The Journal offers no support for its assertion that a personal residence should not be placed in an FLP. First, there is in fact no authority for this, because there is no law which prohibits this action. Second, there is law which allows a personal residence to be owned by non-persons such as land trusts and Qualified Personal Residence Trusts (QPRTs). In both cases, a personal residence is conveyed by its owners to a trust. There is no logical reason why a trust may own a home, but an FLP may not. Moreover, a transfer of a personal residence to a QPRT is done precisely for tax planning reasons – – one of the goals of transferring a personal residence to an FLP. If such a transfer to a QPRT is sound, then so too is the transfer of a personal residence to an FLP.

Another source of confusion in the article was a quote from an asset protection attorney warning that “more than half of somebody’s wealth [should not] go into any one vehicle.” From that quote, readers extrapolated that no more than fifty percent (50%) of a person’s assets should be placed into an FLP.

However, we interpret that attorney’s warning to apply to a situation where a client’s assets are all placed into one FLP; for example, the landlord who owns ten rental properties and places all ten into a single FLP. When a tenant in Building 1 sues the landlord, Buildings 2 through 10, owned by the same FLP, are now vulnerable to the tenant’s judgment. For this reason, we would counsel the client to place each building into a separate FLP. Thus, the tenant plaintiff, if successful in court, might reach Building 1, but not the other buildings which are in different and distinct FLPs. We thus agree with the attorney quoted in the Journal, to the extent his counsel is to isolate each asset that might generate a liability from all other assets by placing each “dangerous” asset in its own FLP.

Clients have asked whether there is a certain percentage of assets that should be transferred to an FLP. The answer is that FLP law nowhere contains a numeric standard. In fact, we have clients who have placed all of their assets into a series of FLPs, with no adverse consequences. There is no prohibition against this, neither in the FLP statutes, nor in the Internal Revenue Code provisions applicable to FLPs.

Clients should not confuse the concept, from fraudulent conveyance law, that a debtor’s transfer of all of his assets would render him insolvent vis-a-vis creditors, and would be an indicia of a fraudulent conveyance. That doctrine has limited applicability when the person owns FLP interests, which have value, and hence the person is not insolvent. Moreover, an FLP can make distributions of money, which could be used by the person to pay creditors, thus further obviating the suggestion of insolvency.

We agree with much of the guidance offered by the Journal article, especially with its warnings against using an FLP as a personal piggy bank, or taking aggressive valuation discounts , and its suggestion of obtaining appraisals for the property transferred to an FLP.

Please contact us with any questions regarding Family Limited Partnerships.